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B. SHANGHAI 5846
C. SHANGHAI 1356
D. SHANGHAI 1355
CLASSIFIED BY: Mary Tarnowka, Political/Economic Chief, U.S.
Consulate Shanghai, State Department.
REASON: 1.4 (b), (d)
1. (SBU) Summary: As the RMB continued to set record highs,
closing at RMB 7.84 per USD on November 27, Shanghai forex
traders expressed appreciation for the greater volatility in the
forex market and predicted continued gradual appreciation of the
RMB. In a series of meetings in late October and November,
representatives of foreign banks trading foreign exchange in
Shanghai discussed market trends and identified future necessary
reforms as including: allowing banks to hold net open positions
shorting the dollar; expanding the 0.3 percent intra-day trading
band; reducing the paperwork required for forex trading; and
liberalizing interest rates to develop more effective market
pricing of forex derivative products. In a November 28 AmCham
Shanghai address, Standard Chartered Senior Economist Stephen
Green shared his analysis of China's foreign exchange policy.
End summary.
2. (SBU) In late October and November, P/E Chief and Econoff met
with representatives from five banks engaged in forex trading in
Shanghai to discuss recent trends and identify necessary
reforms. Those interviewed included: Citigroup Head of Sales
and Trading Paulus Mok, Citigroup Global (Citi) Capital Market
Vice President Alan Chan, and Citigroup Chief FX Dealer You
Jiong; JP Morgan Treasurer and Head of Marketing and Trading
Andrew Zhang; HSBC Deputy Treasurer Ryan Song, Bank of Montreal
(BMO) Managing Director and Head of Asia Robert T. Martin and
(via telephone) Guangzhou-based currency trader David Mu; and
Standard Chartered (SC) Senior Economist Stephen Green.
---------------------------------
CITIGROUP: THE MARKET IS RATIONAL
---------------------------------
3. (C) According to Citigroup's (Citi) Mok, Secretary Paulson's
visit to China was "well-received" in a market that had been
increasingly volatile. He noted that at the beginning of 2006,
daily volume of RMB traded was approximately $500 million. By
the end of October 2006, however, volume was $40-50 billion per
day. He claimed that Citi ranked among the top of foreign banks
trading RMB. Mok said that the market was acting "more
rationally," but that it was clear that the Bank of China (BOC)
had the overriding influence in setting the morning reference
price. Mok believed that in terms of overall trade volume, Citi
usually ranked second or third behind the BOC, vying with HSBC.
When pressed, Mok said that Citi "sometimes sees that it has
some influence" on the morning reference price quoted by CFETS
at 9:15 AM on every trading day, based on a (secret) weighted
average of market maker bids. That being said, Mok added, it
would be impossible to know for sure.
4. (C) Mok said that of the 15 Market Makers, he surmised that
BOC represented 15-20 percent of the total volume traded on the
CFETS system. Citi handled between 5-10 percent (sometimes up
to 15 percent) of daily volume. Mok added that the six foreign
Market Makers accounted for roughly 30 percent of all trade with
the nine Chinese banks accounting for most of the rest. Foreign
banks also had demonstrated a higher tolerance for risk than the
Chinese Market Makers.
5. (SBU) Mok said that the market volume had been increasing due
to two factors. He pointed out that (1) there had been an
increase in the numbers of trades made close to the end of the
trading day (5:30 PM) as traders were increasingly willing to
stake out a position. He noted that the extension of trading
hours on the matching system was helpful in that regard because
it provided a market of last resort for traders needing to clear
their positions. Mok added that (2) Chinese traders were
SHANGHAI 00007096 002 OF 005
getting more experienced and more confident trading.
6. (C) Mok said he expected the PBOC to maintain its long-term
control over the value of the RMB, but to allow greater
intra-day and inter-day volatility. His perception was that the
Chinese authorities and regulators were pleased with the
increased volatility as it gave their banks and corporations a
chance to learn how to react to currency fluctuations.
7. (C) According to Mok's contacts at the PBOC, the increasingly
large foreign currency reserves were beginning to be seen as a
"big burden." Mok, and Citi's head trader You both commented
that PBOC's involvement in forex trading was noticeable
behind-the-scenes, from the time that the rate was set every
morning to the close of trading. Mok stated that PBOC
sterilized its purchases two times a week. Mok surmised that
for some "big deals, like when Sinopec needs $1 billion in
cash," it appeared PBOC worked directly with BoC without going
through the CFETS platform. However, he believed all sales of
U.S. dollars went through CFETS in order to maintain the value
of the RMB.
8. (SBU) According to Mok, Citi's wish list of forex reforms
was: (1) Change the exposure limit calculation to two-way
(allowing traders to both long and short the dollar; currently
traders are only allowed to hold net open positions longing the
dollar); (2) Raise or eliminate the "arbitrarily-set" short- and
long-term foreign debt limits that restrict Citi's ability to
function efficiently as an international bank; (3) Allow
corporations to "net settle" the end result of multiple daily
trades (as banks are now); (4) Standardize and reduce the
amounts of documentation needed for contracts to allow the
ability to do cash flow and budget hedging; and (5) Increase the
intra-day trading band beyond 0.3 percent of the daily reference
price.
-------------------------------
HSBC: NO NEED TO WIDEN THE BAND
-------------------------------
9. (C) According to HSBC's Ryan Song, China's forex market was
"stable and liquid." HSBC had two to three forex traders in
China, compared to the more than 20 forex traders at BOC. Song
said that HSBC perhaps had "some small impact on the value of
the reference price at 9:15 AM," adding that HSBC's influence on
setting the price appeared to be in line with what his traders
understood to be their weighting and size within the CFETS
system.
10. (C) Song also noted the increased market volatility by
pointing out that while a normal trading day might see the
market move between 100 and 200 pips away from that morning's
reference price, it had not been unusual to see 100 pip swings
in price "in a few minutes." In response to a question about
the affect of the Chinese government purchasing large quantities
of dollars, Song said that he and his traders could tell when
huge trades took place since the market sometimes moved
dramatically "from the time when they decided to make a trade
and the two seconds it took for them to manually enter that
trade." Their only explanation for these changes was that PBOC
had been making a large dollar purchase. Song noted that his
traders often squared USD 10-20 million without moving the
market and so speculated that the rapid "drying up of liquidity"
was related to massive purchases of dollars.
11. (C) The forex reform that HSBC would most like to see
implemented, according to Song, was the ability to short the
dollar. In contrast to Citi, however, Song indicated that there
was no need to adjust the 0.3 percent trading band (equivalent
he said to about 2,000 pips) since at its most volatile, the
trading swings had only been 100-200 pips.
12. (C) Song told P/E Chief and Econoff that HSBC had been
attempting to educate Chinese policy makers and regulators on
the importance of continued reforms of the forex market. He
said that HSBC sent representatives to Beijing to educate them
SHANGHAI 00007096 003 OF 005
on the benefits of having a more volatile market-based foreign
exchange market. HSBC also informed Beijing that the next step
should be to allow forex options since banks were ready in terms
of the technical infrastructure and system. Song also said that
HSBC had argued for the creation of a strong inter-bank
borrowing curve -- the vital next step in permitting banks to
accurately price the forwards market.
-------------------------------------------
BANK OF MONTREAL: PUNCHING ABOVE ITS WEIGHT
-------------------------------------------
13. (C) Econoff's meeting on October 25 with BMO's head Robert
Martin was, according to Martin, the first contact he had had
with the USG since coming to China four years previously. He
added that his headquarters had initially viewed the meeting
request with suspicion, convinced that the underlying goal of
the meeting was to figure out its market-share in order to help
a U.S.-bank replace BMO as a CFETS Market Maker. Martin told
econoff that he had persuaded his headquarters to permit the
meeting by reminding them that BMO owned Chicago-based Harris
Bank and so ought to be considered a "U.S.-institution as well."
14. (C) Martin said that part of his institution's defensiveness
was based on its own understanding that its position as one of
six foreign Market Makers in China's forex system was a bit of
an anomaly given its relative size compared to banks like Citi
and HSBC. Martin was very proud of the fact that BMO "punched
above its weight" in China. Martin informed Econoff that BMO
moved into China in the mid-1990s, at a time when few other
banks were interested in China's forex market, in anticipation
of the day when China's forex market would liberalize. It
established good relations with SAFE and other regulatory bodies
and helped to educate Chinese policy and regulation makers on
forex markets. This investment paid off, according to Martin,
with BMO becoming one of the Market Makers. However, this
status was now threatened by other foreign banks attempting to
replace BMO. He said that BMO believed that it ranked 13th or
14th out of all Market Makers in terms of trade volume -- and so
was vulnerable.
15. (C) Martin, whose own status in Shanghai was unofficial
since BMO's application to open a Shanghai branch continued to
be refused, said that BMO had branches in Beijing and Guangzhou
- with both of its branches holding RMB licenses. Martin said
that BMO was not interested in pursuing RMB retail banking.
Martin referred all forex questions to the head trader at BMO's
Guangzhou branch, David Mu.
16. (C) Mu informed Econoff on October 26, via telecon and
email, that intra and inter-day forex movements were based on
four factors: (1) overnight customer positions, including those
of the central bank; (2) speculative positions; (3) SAFE imposed
position limits and the need to square any long position on the
RMB before the end of the trading day; and, (4) SAFE's
evaluation criteria for market makers. Mu noted that SAFE
encouraged participation in all currency pairs by giving higher
scores to banks who quote not just USD/RMB, but also JPY/RMB,
EUR/RMB, GBP/RMB and HKD/RMB -- something that Mu said worked
better for local banks. He also added that inter-day, overnight
USD movement had significant influence on the next trading day's
reference rate. He said that his regression analysis showed a
higher correlation in EUR/USD than in USD/JPY on the RMB.
17. (C) Mu laughingly responded to Econoff's question about the
increase in forex liquidity by stating that Econoff was after
"state secrets which I don't know." That being said, Mu
estimated that liquidity had increased this year by 10 to 20
fold.
18. (C) According to Mu, BMO's number one desire for
institutional reform was the same as other Market Makers --
allowing banks to short the USD onshore. Mu said that not
permitting the shorting of dollars in an attempt to control
speculation on the RMB was completely ineffective. He pointed
out that banks were already among the most regulated
SHANGHAI 00007096 004 OF 005
institutions in the financial market and that not allowing them
to short the USD actually increased their operating risk without
providing tangible benefits for the central bank or other
regulators.
--------------------------------------------- ----
JP MORGAN: NOT A MARKET MAKER, BUT STILL A PLAYER
--------------------------------------------- ----
19. (SBU) Providing the perspective of a non-Market Maker, but
still very active CFETS currency trade, JP Morgan's Andrew Zhang
said that there was a definite need to liberalize the
one-directional nature of the market. Zhang said that an
initial step might be to provide a "limited" ability to short
the USD. JP Morgan had become a "Market Maker" in the forex
swaps market due to its high level of swaps activity in order to
meet its high demand for RMB, according to Zhang.
20. (C) Zhang said that to improve its forex system, the Chinese
government needed to address the foreign debt limit that was
based on a bank's onshore loans without taking into
consideration that bank's other needs for forex. He agreed that
traders needed to be able to hold net open positions both
longing and shorting the dollar. He also said that he did not
think that the Chinese had any desire to liberalize the interest
rate system since it was one of their key mechanisms to control
the economy. Zhang added that PBOC would also not want to widen
the 0.3 percent trading band since "it would make clear how much
it was manipulating the exchange rate."
21. (C) Zhang informed P/E Chief in a separate telecom on
October 26 that JP Morgan was very interested in becoming a
Market Maker on the OTC market. Its major obstacle to this was
that JP Morgan did not meet the criteria set up by CFETS that
Market Makers must be among the top 50 cross-international
border settlement of forex traders. When asked what advantages
JP Morgan would have as a Market Maker that it currently did not
have as a trader, Zhang said that as a Market Maker it would "be
one step closer to the black box" where the Chinese government
made its forex decisions.
22. (SBU) Zhang said that the CFETS forward market "died" in
July 2006 when CFETS changed the rules that allowed it to both
long and short the USD on the Forward Market. This rule, which
according to Stephen Green, did not apply to Market Makers who
were restricted from such trading, meant that JP Morgan could
either long or short on a forward, but did not need to square
the position until the contract matured. Since CFETS unified
its rules for both Market Makers and non-Market Makers in July,
all traders needed to include any forward contracts in
determining their net open position when squaring at the end of
the day. (Note: According to Stephen Green, Market Makers had
never been allowed to benefit from this loophole, but non-Market
Markets had been able to "game the system" until July. End
note.)
-----------------------------------------
Standard Chartered: PBOC still in Control
-----------------------------------------
23. (C) Standard Chartered's (SC) Stephen Green said that
China's economic growth continued to be strong despite the
continued appreciation of the RMB. He noted that PBOC, which he
said favored more movement towards a market-based exchange rate,
made a point of talking about the textile market's continued
strong international performance. However, Green said that the
Ministry of Commerce was "still mostly conservative" on the
issue of RMB appreciation and unconvinced that Chinese industry
would not be hurt by a stronger yuan. Green said that clearly
it was the PBOC moving the inter-day RMB rate, and the BOC, as
PBOC's proxy that controlled the intra-day trading rates as well.
24. (SBU) Green listed several issues that SC had identified as
important steps in the continued reform of China's forex market.
These were: debt quota allocation reform, the ability to hold
net open positions shorting the USD, and restructuring CFETS
SHANGHAI 00007096 005 OF 005
fees.
25. (SBU) Green said that SC would like to see CFETS foreign
debt quota system reallocated based on a bank's actual needs and
not based on the previous year's figures. SC's 50 percent
growth last year did not factor in the debt quota allocated this
year. Green identified CFETS fee restructuring in terms of
international norms as an important structural reform.
26. (C) The next change that CFETS must undertake, according to
Green, was to allow banks to hold net open positions shorting
the USD. He said that traders were "sort of allowed to short
the dollar overnight" already, on an informal basis for "small
amounts." He defined small amounts as $100-200 million and said
that CFETS and SAFE "turned a blind eye" to these transactions
because they seemed to understand that at the end of the trading
day, a bank sometimes happens to end up short.
27. (C) Green also identified the lack of a real U curve as a
central factor in limiting the market for interest rate
products. According to Green, SC was one of three unnamed
foreign banks part of the trial of the Shanghai Interbank
Offered Rate (SHIBOR) that began on October 8. Green said that
the Chinese government knew that it needed to liberalize
interest rates, but was not sure "what should come first." He
pointed out that there were seven loan rates and five deposit
rates set by the PBOC, and that PBOC's next step was to reduce
its involvement to just setting two rates.
28. (C) On November 17, Green informed P/E Chief that the
measures implemented by SAFE in early November to limit offshore
non deliverable forward (NDF) had produced the, perhaps
unintended, effect of increasing RMB appreciation. He said that
after SAFE restricted both foreign and domestic banks operating
in China from trading NDFs, there had not been enough buyers on
Hong Kong NDF market -- leading to the RMB appreciation. Green
also commented that another step taken by SAFE, after
restricting NDF trades outside of China, was the liberalization
of some of the documentation requirements. He said that
Standard and Chartered foreign exchange traders felt that this
was a step in the right direction, but not as much as was
needed.
--------
COMMENT:
--------
29. (C) Having started the process of piece-meal reform of its
currency market, China is faced with increasing demands from its
forex traders -- interested in maximizing their own profits --
to continue the process. However, the more China liberalizes
and reforms its forex market, the less it will be able to use
politically-based macro-economic controls to limit inflation and
to direct investment. For now, while China's technical and
regulatory framework for a free-market based floating currency
is in place, forex rates still appear to be directed based on
political calculations.
JARRETT

Raw content

C O N F I D E N T I A L SECTION 01 OF 05 SHANGHAI 007096
SIPDIS
SIPDIS
STATE PASS FEDERAL RESERVE BOARD FOR JOHNSON/SCHINDLER; SF FRB
FOR CURRAN/LUNG; NY FRB FOR CLARK/CRYSTAL/MOSELEY
TREASURY FOR ADAMS, AND OASIA - DOHNER, BAKER, CUSHMAN
USDOC FOR ITA A/DAS MELCHER, MCQUEEN
NSC FOR HUBBARD AND TONG
E.O. 12958: DECL: 11/30/2031
TAGS: EFIN, ECON, PREL, CH
SUBJECT: CHINA FOREX: AFTER NEW HIGHS, NEXT STEPS NEEDED
REF: A. SHANGHAI 7091
B. SHANGHAI 5846
C. SHANGHAI 1356
D. SHANGHAI 1355
CLASSIFIED BY: Mary Tarnowka, Political/Economic Chief, U.S.
Consulate Shanghai, State Department.
REASON: 1.4 (b), (d)
1. (SBU) Summary: As the RMB continued to set record highs,
closing at RMB 7.84 per USD on November 27, Shanghai forex
traders expressed appreciation for the greater volatility in the
forex market and predicted continued gradual appreciation of the
RMB. In a series of meetings in late October and November,
representatives of foreign banks trading foreign exchange in
Shanghai discussed market trends and identified future necessary
reforms as including: allowing banks to hold net open positions
shorting the dollar; expanding the 0.3 percent intra-day trading
band; reducing the paperwork required for forex trading; and
liberalizing interest rates to develop more effective market
pricing of forex derivative products. In a November 28 AmCham
Shanghai address, Standard Chartered Senior Economist Stephen
Green shared his analysis of China's foreign exchange policy.
End summary.
2. (SBU) In late October and November, P/E Chief and Econoff met
with representatives from five banks engaged in forex trading in
Shanghai to discuss recent trends and identify necessary
reforms. Those interviewed included: Citigroup Head of Sales
and Trading Paulus Mok, Citigroup Global (Citi) Capital Market
Vice President Alan Chan, and Citigroup Chief FX Dealer You
Jiong; JP Morgan Treasurer and Head of Marketing and Trading
Andrew Zhang; HSBC Deputy Treasurer Ryan Song, Bank of Montreal
(BMO) Managing Director and Head of Asia Robert T. Martin and
(via telephone) Guangzhou-based currency trader David Mu; and
Standard Chartered (SC) Senior Economist Stephen Green.
---------------------------------
CITIGROUP: THE MARKET IS RATIONAL
---------------------------------
3. (C) According to Citigroup's (Citi) Mok, Secretary Paulson's
visit to China was "well-received" in a market that had been
increasingly volatile. He noted that at the beginning of 2006,
daily volume of RMB traded was approximately $500 million. By
the end of October 2006, however, volume was $40-50 billion per
day. He claimed that Citi ranked among the top of foreign banks
trading RMB. Mok said that the market was acting "more
rationally," but that it was clear that the Bank of China (BOC)
had the overriding influence in setting the morning reference
price. Mok believed that in terms of overall trade volume, Citi
usually ranked second or third behind the BOC, vying with HSBC.
When pressed, Mok said that Citi "sometimes sees that it has
some influence" on the morning reference price quoted by CFETS
at 9:15 AM on every trading day, based on a (secret) weighted
average of market maker bids. That being said, Mok added, it
would be impossible to know for sure.
4. (C) Mok said that of the 15 Market Makers, he surmised that
BOC represented 15-20 percent of the total volume traded on the
CFETS system. Citi handled between 5-10 percent (sometimes up
to 15 percent) of daily volume. Mok added that the six foreign
Market Makers accounted for roughly 30 percent of all trade with
the nine Chinese banks accounting for most of the rest. Foreign
banks also had demonstrated a higher tolerance for risk than the
Chinese Market Makers.
5. (SBU) Mok said that the market volume had been increasing due
to two factors. He pointed out that (1) there had been an
increase in the numbers of trades made close to the end of the
trading day (5:30 PM) as traders were increasingly willing to
stake out a position. He noted that the extension of trading
hours on the matching system was helpful in that regard because
it provided a market of last resort for traders needing to clear
their positions. Mok added that (2) Chinese traders were
SHANGHAI 00007096 002 OF 005
getting more experienced and more confident trading.
6. (C) Mok said he expected the PBOC to maintain its long-term
control over the value of the RMB, but to allow greater
intra-day and inter-day volatility. His perception was that the
Chinese authorities and regulators were pleased with the
increased volatility as it gave their banks and corporations a
chance to learn how to react to currency fluctuations.
7. (C) According to Mok's contacts at the PBOC, the increasingly
large foreign currency reserves were beginning to be seen as a
"big burden." Mok, and Citi's head trader You both commented
that PBOC's involvement in forex trading was noticeable
behind-the-scenes, from the time that the rate was set every
morning to the close of trading. Mok stated that PBOC
sterilized its purchases two times a week. Mok surmised that
for some "big deals, like when Sinopec needs $1 billion in
cash," it appeared PBOC worked directly with BoC without going
through the CFETS platform. However, he believed all sales of
U.S. dollars went through CFETS in order to maintain the value
of the RMB.
8. (SBU) According to Mok, Citi's wish list of forex reforms
was: (1) Change the exposure limit calculation to two-way
(allowing traders to both long and short the dollar; currently
traders are only allowed to hold net open positions longing the
dollar); (2) Raise or eliminate the "arbitrarily-set" short- and
long-term foreign debt limits that restrict Citi's ability to
function efficiently as an international bank; (3) Allow
corporations to "net settle" the end result of multiple daily
trades (as banks are now); (4) Standardize and reduce the
amounts of documentation needed for contracts to allow the
ability to do cash flow and budget hedging; and (5) Increase the
intra-day trading band beyond 0.3 percent of the daily reference
price.
-------------------------------
HSBC: NO NEED TO WIDEN THE BAND
-------------------------------
9. (C) According to HSBC's Ryan Song, China's forex market was
"stable and liquid." HSBC had two to three forex traders in
China, compared to the more than 20 forex traders at BOC. Song
said that HSBC perhaps had "some small impact on the value of
the reference price at 9:15 AM," adding that HSBC's influence on
setting the price appeared to be in line with what his traders
understood to be their weighting and size within the CFETS
system.
10. (C) Song also noted the increased market volatility by
pointing out that while a normal trading day might see the
market move between 100 and 200 pips away from that morning's
reference price, it had not been unusual to see 100 pip swings
in price "in a few minutes." In response to a question about
the affect of the Chinese government purchasing large quantities
of dollars, Song said that he and his traders could tell when
huge trades took place since the market sometimes moved
dramatically "from the time when they decided to make a trade
and the two seconds it took for them to manually enter that
trade." Their only explanation for these changes was that PBOC
had been making a large dollar purchase. Song noted that his
traders often squared USD 10-20 million without moving the
market and so speculated that the rapid "drying up of liquidity"
was related to massive purchases of dollars.
11. (C) The forex reform that HSBC would most like to see
implemented, according to Song, was the ability to short the
dollar. In contrast to Citi, however, Song indicated that there
was no need to adjust the 0.3 percent trading band (equivalent
he said to about 2,000 pips) since at its most volatile, the
trading swings had only been 100-200 pips.
12. (C) Song told P/E Chief and Econoff that HSBC had been
attempting to educate Chinese policy makers and regulators on
the importance of continued reforms of the forex market. He
said that HSBC sent representatives to Beijing to educate them
SHANGHAI 00007096 003 OF 005
on the benefits of having a more volatile market-based foreign
exchange market. HSBC also informed Beijing that the next step
should be to allow forex options since banks were ready in terms
of the technical infrastructure and system. Song also said that
HSBC had argued for the creation of a strong inter-bank
borrowing curve -- the vital next step in permitting banks to
accurately price the forwards market.
-------------------------------------------
BANK OF MONTREAL: PUNCHING ABOVE ITS WEIGHT
-------------------------------------------
13. (C) Econoff's meeting on October 25 with BMO's head Robert
Martin was, according to Martin, the first contact he had had
with the USG since coming to China four years previously. He
added that his headquarters had initially viewed the meeting
request with suspicion, convinced that the underlying goal of
the meeting was to figure out its market-share in order to help
a U.S.-bank replace BMO as a CFETS Market Maker. Martin told
econoff that he had persuaded his headquarters to permit the
meeting by reminding them that BMO owned Chicago-based Harris
Bank and so ought to be considered a "U.S.-institution as well."
14. (C) Martin said that part of his institution's defensiveness
was based on its own understanding that its position as one of
six foreign Market Makers in China's forex system was a bit of
an anomaly given its relative size compared to banks like Citi
and HSBC. Martin was very proud of the fact that BMO "punched
above its weight" in China. Martin informed Econoff that BMO
moved into China in the mid-1990s, at a time when few other
banks were interested in China's forex market, in anticipation
of the day when China's forex market would liberalize. It
established good relations with SAFE and other regulatory bodies
and helped to educate Chinese policy and regulation makers on
forex markets. This investment paid off, according to Martin,
with BMO becoming one of the Market Makers. However, this
status was now threatened by other foreign banks attempting to
replace BMO. He said that BMO believed that it ranked 13th or
14th out of all Market Makers in terms of trade volume -- and so
was vulnerable.
15. (C) Martin, whose own status in Shanghai was unofficial
since BMO's application to open a Shanghai branch continued to
be refused, said that BMO had branches in Beijing and Guangzhou
- with both of its branches holding RMB licenses. Martin said
that BMO was not interested in pursuing RMB retail banking.
Martin referred all forex questions to the head trader at BMO's
Guangzhou branch, David Mu.
16. (C) Mu informed Econoff on October 26, via telecon and
email, that intra and inter-day forex movements were based on
four factors: (1) overnight customer positions, including those
of the central bank; (2) speculative positions; (3) SAFE imposed
position limits and the need to square any long position on the
RMB before the end of the trading day; and, (4) SAFE's
evaluation criteria for market makers. Mu noted that SAFE
encouraged participation in all currency pairs by giving higher
scores to banks who quote not just USD/RMB, but also JPY/RMB,
EUR/RMB, GBP/RMB and HKD/RMB -- something that Mu said worked
better for local banks. He also added that inter-day, overnight
USD movement had significant influence on the next trading day's
reference rate. He said that his regression analysis showed a
higher correlation in EUR/USD than in USD/JPY on the RMB.
17. (C) Mu laughingly responded to Econoff's question about the
increase in forex liquidity by stating that Econoff was after
"state secrets which I don't know." That being said, Mu
estimated that liquidity had increased this year by 10 to 20
fold.
18. (C) According to Mu, BMO's number one desire for
institutional reform was the same as other Market Makers --
allowing banks to short the USD onshore. Mu said that not
permitting the shorting of dollars in an attempt to control
speculation on the RMB was completely ineffective. He pointed
out that banks were already among the most regulated
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institutions in the financial market and that not allowing them
to short the USD actually increased their operating risk without
providing tangible benefits for the central bank or other
regulators.
--------------------------------------------- ----
JP MORGAN: NOT A MARKET MAKER, BUT STILL A PLAYER
--------------------------------------------- ----
19. (SBU) Providing the perspective of a non-Market Maker, but
still very active CFETS currency trade, JP Morgan's Andrew Zhang
said that there was a definite need to liberalize the
one-directional nature of the market. Zhang said that an
initial step might be to provide a "limited" ability to short
the USD. JP Morgan had become a "Market Maker" in the forex
swaps market due to its high level of swaps activity in order to
meet its high demand for RMB, according to Zhang.
20. (C) Zhang said that to improve its forex system, the Chinese
government needed to address the foreign debt limit that was
based on a bank's onshore loans without taking into
consideration that bank's other needs for forex. He agreed that
traders needed to be able to hold net open positions both
longing and shorting the dollar. He also said that he did not
think that the Chinese had any desire to liberalize the interest
rate system since it was one of their key mechanisms to control
the economy. Zhang added that PBOC would also not want to widen
the 0.3 percent trading band since "it would make clear how much
it was manipulating the exchange rate."
21. (C) Zhang informed P/E Chief in a separate telecom on
October 26 that JP Morgan was very interested in becoming a
Market Maker on the OTC market. Its major obstacle to this was
that JP Morgan did not meet the criteria set up by CFETS that
Market Makers must be among the top 50 cross-international
border settlement of forex traders. When asked what advantages
JP Morgan would have as a Market Maker that it currently did not
have as a trader, Zhang said that as a Market Maker it would "be
one step closer to the black box" where the Chinese government
made its forex decisions.
22. (SBU) Zhang said that the CFETS forward market "died" in
July 2006 when CFETS changed the rules that allowed it to both
long and short the USD on the Forward Market. This rule, which
according to Stephen Green, did not apply to Market Makers who
were restricted from such trading, meant that JP Morgan could
either long or short on a forward, but did not need to square
the position until the contract matured. Since CFETS unified
its rules for both Market Makers and non-Market Makers in July,
all traders needed to include any forward contracts in
determining their net open position when squaring at the end of
the day. (Note: According to Stephen Green, Market Makers had
never been allowed to benefit from this loophole, but non-Market
Markets had been able to "game the system" until July. End
note.)
-----------------------------------------
Standard Chartered: PBOC still in Control
-----------------------------------------
23. (C) Standard Chartered's (SC) Stephen Green said that
China's economic growth continued to be strong despite the
continued appreciation of the RMB. He noted that PBOC, which he
said favored more movement towards a market-based exchange rate,
made a point of talking about the textile market's continued
strong international performance. However, Green said that the
Ministry of Commerce was "still mostly conservative" on the
issue of RMB appreciation and unconvinced that Chinese industry
would not be hurt by a stronger yuan. Green said that clearly
it was the PBOC moving the inter-day RMB rate, and the BOC, as
PBOC's proxy that controlled the intra-day trading rates as well.
24. (SBU) Green listed several issues that SC had identified as
important steps in the continued reform of China's forex market.
These were: debt quota allocation reform, the ability to hold
net open positions shorting the USD, and restructuring CFETS
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fees.
25. (SBU) Green said that SC would like to see CFETS foreign
debt quota system reallocated based on a bank's actual needs and
not based on the previous year's figures. SC's 50 percent
growth last year did not factor in the debt quota allocated this
year. Green identified CFETS fee restructuring in terms of
international norms as an important structural reform.
26. (C) The next change that CFETS must undertake, according to
Green, was to allow banks to hold net open positions shorting
the USD. He said that traders were "sort of allowed to short
the dollar overnight" already, on an informal basis for "small
amounts." He defined small amounts as $100-200 million and said
that CFETS and SAFE "turned a blind eye" to these transactions
because they seemed to understand that at the end of the trading
day, a bank sometimes happens to end up short.
27. (C) Green also identified the lack of a real U curve as a
central factor in limiting the market for interest rate
products. According to Green, SC was one of three unnamed
foreign banks part of the trial of the Shanghai Interbank
Offered Rate (SHIBOR) that began on October 8. Green said that
the Chinese government knew that it needed to liberalize
interest rates, but was not sure "what should come first." He
pointed out that there were seven loan rates and five deposit
rates set by the PBOC, and that PBOC's next step was to reduce
its involvement to just setting two rates.
28. (C) On November 17, Green informed P/E Chief that the
measures implemented by SAFE in early November to limit offshore
non deliverable forward (NDF) had produced the, perhaps
unintended, effect of increasing RMB appreciation. He said that
after SAFE restricted both foreign and domestic banks operating
in China from trading NDFs, there had not been enough buyers on
Hong Kong NDF market -- leading to the RMB appreciation. Green
also commented that another step taken by SAFE, after
restricting NDF trades outside of China, was the liberalization
of some of the documentation requirements. He said that
Standard and Chartered foreign exchange traders felt that this
was a step in the right direction, but not as much as was
needed.
--------
COMMENT:
--------
29. (C) Having started the process of piece-meal reform of its
currency market, China is faced with increasing demands from its
forex traders -- interested in maximizing their own profits --
to continue the process. However, the more China liberalizes
and reforms its forex market, the less it will be able to use
politically-based macro-economic controls to limit inflation and
to direct investment. For now, while China's technical and
regulatory framework for a free-market based floating currency
is in place, forex rates still appear to be directed based on
political calculations.
JARRETT